Broken France?

This note was originally published February 14, 2013 at 12:17 in Macro

We’ve long had a skeptical eye on Socialist President François Hollande since he entered the stage in May 2012, beginning with his very loud “tax the rich” campaign slogan and lack of focus on reducing France's fiscal fat. With fears now decidedly marginalized on the dissolution of the Eurozone; no imminent threat of a sovereign needing a bailout; and Draghi’s OMT bazooka still calming markets, we return to France, the region’s second largest economy, for a closer look at the risks we see developing that may be overlooked.

What’s mattered greatly to many investors at the country level since the “crisis” began is countries meeting or exceeding their growth targets and reducing their debt and deficit levels. France, not unlike what we’ve seen from peripheral countries since 2009, looks to miss its 2013 GDP and deficit targets. In recent days President Hollande has hinted at a willingness to change the growth forecast from +0.8% to +0.3%-0.4%, however has not backed off the deficit target of 3% of GDP. We think a revision to both is a question of when, not if.

Interestingly, the sticking point on when this change in forecast could result may have to do directly with the timing of a European Commission’s economic report on the Eurozone. It is expected to come out in late February and show that French growth should be in the +0.3%-0.4% range and that France is projected to undershoot its deficit reduction target. A recent state audit should also influence Hollande – it revealed that in a scenario of +0.3% growth, inline with current IMF projections, the deficit would be 25bps over the target, or 3.25%, and added that the state has relied too much on tax increases and needs to focus on spending cuts to attain its targets.

Beyond the Deficit Are Storm Clouds

While a miss of its deficit target may not cripple confidence in France, it adds to a perfect storm of negative trending risks, which include:

Public debt – pushing 91% (as a % of GDP) - France is above the level of 90% that economists Reinhart and Rogoff have indicated as destructive to growth.

Credit Rating – Fitch is the only main agency to maintain its AAA status. S&P is at AA and Moody’s at Aa1. We expect all three to be lined up at AA in 2013 and for this reduction in credit standing to weigh on its public finances, and put upward pressure on yields. Note: The 10YR is currently trading at 2.26% (versus 1.64% in Germany), and has remained stubbornly low over the intermediate term despite the risk premiums we see, a development that we believe has a high probability of inflecting in 2013.

Competitiveness Drag – Hollande’s policy to tax the rich (75% on those making €1MM or more) is not only driving out his countrymen but sending negative investment signals to the business community. Hollande has moved the top rate of capital gains tax from 34.5% to 62.2%. For reference these levels compare with 21% in Spain, 26.4% in Germany and 28% in Britain.

Hamstrung Spending – we believe that Hollande will not be able to issue additional spending cutsdue to push back on the street against austerity. Politically, Hollande also doesn’t have the popular support to make an estimated €5B in additional cuts to attain the deficit target.

Bank Leverage – French banks remain an outside concern due to their leverage to the periphery. While we expect Draghi and Co. to keep the union together at all costs, the weight of a still imbalanced financial sector could sway sovereign sentiment.

Economic Misses

Today Eurostat reported initial GDP figures for Q4 2012. France’s Q4GDP came in at -0.3% Q/Q versus expectations of -0.2% and +0.1% in Q3. While France outperformed the Eurozone aggregate of -0.6% Q/Q (versus expectations of -0.4%), the high frequency data that we track continues to paint a negative trend for France, one that inflects versus the larger peer economies of Germany and the UK.

France’s PMI Services number for JAN was 43.6 JAN vs 45.2 in DEC and Manufacturing fell to 42.9 in JAN vs 44.6 in DEC, both decidedly under the 50 line representing contraction.

Further, the policy measures that Hollande has implemented are showing up in confidence readings. Business Confidence has rolled down the mountain sincea high in March 2012, Consumer Confidence has been flat to down since Hollande’s election, and Consumer Spending has been under 1% since mid 2011 and negative for the last 5 consecutive months.

Given France debt drag, likely misses on 2013 GDP and deficit reduction, and financial and economic constrains, the country is one to watch given the downside risks. From a capital markets perspective the country has been surprisingly resilient, but this could well change. While the wave of sentiment may be more focused on the governments of Italy and Spain currently, we caution that the risks in France could drive a stagflationary set-up in the country for much longer than is currently being priced in. We think the Hollande’s political handcuffs will prevent necessary spending cuts and his decidedly anti-business tax policy will chase good money out of the country. Stay tuned.

BEAM - What Were They Thinking?

About a week ago (2/11), in a move right out of the saloon owners manual in the Wild West, BEAM announced that it would be cutting the alcohol content of its Maker's Mark bourbon to 42% from 45%. The company reversed that ill-conceived decision today.

The initial move came about as the result of a high-quality problem - short-term demand in excess of supply. However, high quality problems demand high-quality solutions, and the initial "solution" boiled down to serving everyone that purchased a bottle of Maker's Mark a watered-down drink. It was a decision that would have had serious repercussions in 1890's Tombstone as well as 2013 Tribeca.

The company reversed its decision today:

"You spoke. We listened. And we’re sincerely sorry we let you down."

Note to management - all you had to do was ask, or use some common sense.

This note is admittedly more fun than actionable, but I think there is a lesson to be learned about managing the equity of a brand. Maker's Mark is a great brand whose equity has been built up over many years - it should be tinkered with only after great deliberation and always with an eye toward enhancing the long-term value of the brand.

May your drinks never be watered down.

Call with questions,

Rob

Robert Campagnino

Managing Director

HEDGEYE RISK MANAGEMENT, LLC

E:

P:

Matt Hedrick

Senior Analyst

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02/18/13 07:02 AM EST

Flows Follow

This note was originally published
at 8am on February 04, 2013 for Hedgeye subscribers.

“You have to be the first one in line. That’s how leaders are born.”

-Ray Lewis

Did global growth stop slowing in mid-to-late November? Is #GrowthStabilizing bad for Gold and Bonds? These questions are now rhetorical ones.

“When you want to win a game, you have to teach. When you lose a game, you have to learn.” -Tom Landry

Our congratulations to Ray Lewis and the Baltimore Ravens. #winning

Back to the Global Macro Grind…

US Equities were up for the 5th consecutive week and long-term US Treasury Yields continued to breakout to the upside last week (10yr Yield up another +6bps to 2.01%) as fund flows into US Equities continue to surprise on the upside.

The 1st two points of the process were trivial. We wrote about them every day. The last point about flows was the hardest to nail down. While we usually get the memo on flows after the fact, we do know what leads them.

Q: What leads people out of Gold/Bonds and into Equities? A: Growth Expectations.

Example (Gold):

Gold made a long-term lower-high in mid November at $1755/oz (versus the all-time high in 2011)

Gold snapped our intermediate-term TREND line of $1698 in early December

Gold net long positions (futures and options contracts) crashed to 82,081 last week

Crashed? Yes. Last week the bulls (who had been buying Gold contracts the whole way down from October to January) capitulated, selling the net long position in Gold contracts down -24% wk-over-wk.

Despite Gold and Silver being down another -0.2% and -1.1%, respectively, this morning, from an immediate-term TRADE duration perspective this is obviously an interesting contrarian indicator. But what does it tell you about longer-term growth expectations?

What has the Treasury Bond market been telling you?

10yr US Treasury Yields made higher-long-term lows in November-December in the 1.57-1.61% range

10yr US Treasury Yield broke out above our intermediate-term TREND line of 1.73% in mid-December 2012

10yr US Treasury Yields are up another 5 basis points this morning (that’s a lot in a day) to 2.05%

At the same time, the HYG (High Yield) and Junk (JNK) Bond ETFs finally broke my immediate-term TRADE lines of support last week. With Investment Grade and Junk Bond yields up another +1.9% and +3.3% last week, that was new for this cycle (not new at turns in other major cycles).

The concept of buying “High Yield” debt (that has record low yields) is far from simple; especially if people start to bake in that Ben Bernanke’s money printing days are over. This is why we are so focused on the slope of growth expectations for:

Global GDP Growth

US Employment Growth

US House Price Inflation Growth

All 3 of these factors can drive Gold/Bond prices down until people actually start to believe we could re-flate the Commodity Inflation Bubble (which peaked alongside Gold in 2011). Which, in turn, could slow growth (again). That’s why:

CRB Commodities Index closing 1 point inside of our long-term TAIL line of 306 last week is a NEW concern

Oil Prices up another +1.8% and +2.9% on WTIC and Brent last week are a mounting concern

5-year Breakevens up +6.5% last week in the US (Bernanke’s former inflation expectations bogey) matter too

Whether you were bullish or bearish throughout this 2-month move doesn’t matter anymore. Today is a new day. You are either first on the line to register what is changing on the margin in macro, or you are not. We’ll do our best to stand alongside you.

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02/17/13 05:14 PM EST

After Heinz, What's Next?

Both Berkshire Hathaway and 3G prefer to invest in iconic, global brands, and Heinz certainly is that. 3G also has a reputation for aggresive cost cutting, and there appears to be room for that at Heinz as well.

In order to answer the oft-posed (last week, at least) question of "what's next", we took a look at the companies in the packaged food space in terms of how efficiently capital (human and fixed) was utilized. As it turns out, the answer at HNZ was "not particularly well". The companies positioned in the lower left corner of the chart below are at the lower end of the packaged food space on the following two metrics:

Sales per employee

Sales/Average Property Plant and Equipment (PPE)

Based on that analysis (admittedly, imperfect), CPB as a short might cause me some sleepness nights given that someone may see an opportunity there beyond what current management has been able to exploit. I think the analysis also supports our belief that HSH and POST could be targets at some point in the future.

We next wanted to look for brands that might not be as well supported as could be, with an asssociated low sales productivity as measured by sales per employee - again, imperfect, but directionally helpful.

Again, Heinz appears in the "bad" quadrant, and HSH right next to it - though this is weakness recognized by HSH management, with a plan to improve upon the current level of brand investment. In this case, POST brands appear well-supported.

HAIN's position on the chart surprised us at first, then we thought about it and remembered that management there prefers to buy someone else's hard work and grow through acquisitions rather than do the heavy lifting required to build brands.

Where does that leave us?

Well, looking at the data here, we can see the opportunity that Berkshire Hathaway and 3G may be poised to exploit. Further, we continue to believe that HSH and POST could be targets at some point in the future. Finally, given it's proximity to HNZ on the metrics we discussed, a short position in CPB makes us somewhat uneasy.

Enjoy the holiday tomorrow,

Rob

Robert Campagnino

Managing Director

HEDGEYE RISK MANAGEMENT, LLC

E:

P:

Matt Hedrick

Senior Analyst

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02/15/13 04:38 PM EST

THE WEEK AHEAD

The Economic Data calendar for the week of the 18th of February through the 22nd is full of critical releases and events. Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.

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02/15/13 04:33 PM EST

TRADE OF THE DAY: XLE

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